How We Model Our General Contractor (GC) Fees
Alright, let’s solve this once and for all – What’s the best payment structure between a GC and their client to ensure that their incentive structures are aligned?
We’re uniquely positioned to understand both sides of this question as we’ve been on both sides of this relationship. As a client, we saw the negatives of “fixed cost” price models (even with guaranteed maximum’s in place) and we saw the negatives of “cost +” models, which are the two most popular ways of structuring an agreement at our level.
Fixed Price Models
Fixed price models are great because you know your total number from the start – and even have a “worst case” with your guaranteed maximum. However, like with everything as a developer, it all falls on you at the end. I don’t care what someone has as their “guaranteed max” – if the budget goes over then you are either going to deal with an exceptionally honest GC (rarity) who will take a loss, or (more likely) you will be given excuses about why it wasn’t their fault and how the overages actually fall on you. Then you’re left with the decision to pay for it and keep it moving or get into a long and arduous lawsuit that will cost you more money in the end, even if you win, because of your holding costs. It’s simple -- you have less leverage than them. Additionally, with this model it is extremely common for the GC to go back to product suppliers and sub-contractors and negotiate their costs down because if they talk the Jimbo the plumber from 30k to 28k, the GC makes an extra 2k. The only problem with that is now you have a pissed off plumber who will not be prioritizing your job, so he’s more likely to push you back on his schedule and rush through the work while he’s there – leaving you with a subpar product that took longer to build.
Cost-Plus Models
Cost-Plus models are the solution then, right? Not quite . . . This is where you pay for all the actual hard costs and the GC will make a % above those costs. Let’s continue this example of our friendly plumber Jimbo. He would normally charge $30k for your plumbing job, but now he’s a bit busy and so he says he’d do it for $35k. This is completely normal and expected because everybody’s schedule goes through waves. We counteract this by pricing a few subs each time so if Jimbo is busy and at $35k, we’ll call Billbo, who’s schedule is a bit leaner, and hire him at $30k. Your cost-plus GC is literally incentivized to run with the $35k bid because, after all, he’s making more money! Now Jimbo is happy with the job so you’ll be left with a job well done in a fair timeline, but needlessly $5k too expensive.
What’s The Solution Then?
We employ a cost-plus fixed fee model where we are paid our fee in accordance with the % of work finished. When we started this enterprise we were only building for ourselves and we treat our relationship with clients no differently. We start with an estimate for hard construction costs – these are the same costs as we would pay for our own project. These numbers are fairly rough as they’re based on assumptions – however we’re pretty conservative and we include a 5-10% contingency. We then decide what amount of money would make the job worth it for us to take on the project, fix that fee from day one and separate it as an individual line item. This is our entire fee – no markups on material, no markups on labor, no hidden fees. If Jimbo comes in $2k cheaper then you, the owner, save $2k. Since we’re only paid for work that is complete we’re incentivized to finish the project quickly – but not at the expense of quality because we offer a 1 year warranty for all work that was done under our scope.
Once we sign a contract, we get to work immediately to transform our estimate into a budget with real numbers. We bid out each trade and generate material orders with suppliers to lock in costs. For finish selections we have a selections sheet that we collaborate on with the client. Theoretically we could do all of this before a project even starts and get an actual budget with real predictability! Our fee doesn’t change. The client can make material upgrades without needlessly paying us more. We are incentivized to deliver a high quality product without defects (we have to fix them after all) as quickly as possible!
We’re fully open book throughout the entire process sharing orders, invoices and even showing the multiple bids from various subs to allow the client ultimate transparency. There have even been instances where the client decides to go with a higher priced sub contractor because of various reasons such as timeline or our perception of quality differences. With this model, we’re all on the same team and can put our full focus towards successfully executing the project. This allows for ultimate transparency, ultimate predictability and ultimate efficiency so we can all win.